Construction LendersRisk Management Roundtable

January 24, 2019

1

PARTNER CLRM 2019 MARKET UPDATE:8 Trends to Watch in the New Year

Presented by: Dianne Crocker, Principal Analyst, EDR InsightJanuary 24, 2019

1.A NEW NORMAL:Rate of growth in property deals is decelerating.

2018’s REVERSAL IN CRE TRANSACTIONS

QUARTERLY ANNUAL

$-

$100

$200

$300

$400

$500

$600

2014 2015 2016 2017 2018

U.S. COMMERCIAL REAL ESTATE TRANSACTIONS(Billion $, preliminary data as of Jan. 17)

Development Site Sales Rebounded in 2018

The CRE Forecast: Is 2018 As Good As It Gets?

$72

$155

$261$310

$378

$453

$569

$511 $490$520

$450$415

$-

$100

$200

$300

$400

$500

$600

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Actual Forecast

13-year average($313B)

2.CONSTRUCTION SPENDING ANDLENDING:Will remain active amid stiff competitionfrom the unregulated

Through October 2018, construction spending up 5.1% above the same period of 2017.

U.S. Construction Spending On the Rise

• Debt funds stepped into the gapleft when 2015 HVCRE regulationsled big banks to curtailconstruction lending.

• Local/regional banks still lendmore, but debt funds have posteda sharp increase for their marketshare.

• Uber-competitive playing field:6 out of 8 classes had at least10% of the market in 1H18

SHIFTS IN THE DISTRIBUTION OF CONSTRUCTION LENDERS

…Debt Funds’ Lending Skewed to Higher LTVs

13

TOP ORIGINATORS IN CONSTRUCTION LENDINGTOP CONSTRUCTION LENDERS, 1H2018

1. Wells Fargo 11. Otera Capital

2. Blackstone Mortgage Trust 12. CIBC

3. Bank OZK 13. Comerica Bank

4. Bank of America 14. BMO Financial Group

5. JP Morgan 15. Dougherty & Company

6. US Bancorp 16. Madison Realty Capital

7. SunTrust 17. Goldman Sachs

8. PNC Fin’l Services 18. Bank of the West

9. M&T Bank 19. Starwood Property Trust

10. Fifth Third Bank 20. MassMutual Life

3.RETAIL’S PAIN IS INDUSTRIAL’S GAIN:Industrial will win the asset war

EVERY $1B INE-COMMERCESALES

AVAILABLEWAREHOUSE SPACEAT LOWEST LEVELSINCE 2000

THE NEED FOR1.25MSF OFWAREHOUSE SPACE

MULTIFAMILY:• Still strong in areas with constrained development• Benefits from dynamics that favor renting over homebuying

RETAIL:• Strong demand for adaptive reuse and repurposing of vacant, underutilized or obsolete properties

OFFICE:• Relatively moderate construction, benefits from strong job growth• Demand for energy efficiency improvements

MEANWHILE IN THE OTHER ACTIVE ASSET CLASSES:

17

4.THE QUEST FOR YIELD:Casting a Wider Net to Secondary Metros

CONTINUED MIGRATION TO SMALLER METROS

Sources: EDR ScoreKeeper model; Urban Land Institute-PricewaterhouseCoopers Emerging Trends in Real Estate, 2019.

HIGH-GROWTH DUEDILIGENCE MARKETS

1. San Francisco (19%)2. Orlando (16%)3. San Diego (15%)4. Tampa (15%)5. Indianapolis (14%)6. Columbus (14%)7. Houston (13%)8. Stamford (12%)9. Charlotte (11%)10.Detroit (10%)

THIS YEAR’S TOP CREMARKETS

1. Dallas/Fort Worth2. New York-

Brooklyn3. Raleigh/Durham4. Orlando5. Nashville6. Austin7. Boston8. Denver9. Charlotte10. Tampa

Amazon's HQ2 Impact On Crystal City And Long Island City

5.OPPORTUNITY IN OPPORTUNITY ZONES:Tax incentives lure investment capital

• Nearly 9,000 opportunity zones across theU.S.

• One of the most attractive tax incentives inyears.

• Emphasis is on reinvestment into newconstruction or major rehabilitation

• Already seeing an increase in:• Interest from banks and insurance

companies to lend in these areas• New funds deploying capital• State/local incentives added as icing on

the cake• Broad interest from investors,

developers…

Opportunity Zones: Tax Breaks Drive Reuse, Renovation

22

The Locus of Development Is Already Shifting to Opportunity Zones

• Since Q4’17, development sitesales within opportunity zoneshave grown at high double-digitrates.

• Value of construction startswithin opportunity zonesclimbed to 18% of the markettotal by Q3’18.

• Development site sales areclearly a leading indicator of ashift in construction in thecoming years to opportunityzones.

6.DEAL OR NO DEAL?Rising interest rates/slowing appreciationwill change the equation.

Higher Cost of Capital As Yields Moderate: Be Diligent

7.PAY ATTENTION TO THE “R” WORDS:Prepare for recession, protect from risk

SOURCE: EDR Industry Benchmark Survey of Environmental Professionals, August 2018.424 responses

• Stronger capital buffers• Smarter risk management• Greater understanding of environmental risks• Many economists peg 2020 as the year recessionary conditions take room

“Our banking system’s risk management is the best it’s ever been. Risk used to bestuffed in the legal department, and now it’s been elevated to one of the most seniorpositions at a financial institution. There’s an elevated status to being a risk officertoday. Now CEOs are talking about practices that will or won’t fit within their riskparameters.”Joseph Otting, Comptroller of the Currency

How Are Things Different Than Before the GFC?

28

8.CONSTRUCTION FORECAST:Labor shortages, rising costs

• The #1 real estate and development concern today• Land costs a close second.• Margins are going to be squeezed, cost overruns

incurred, and values under pressure unless rents andnet operating income can be increased to cover theincreasing costs of new construction.

“Rising construction costs may be the most undertoldstory of 2018 that should become a material story in2019.”KC Conway, CCIM

Rising Construction Costs a Concern

30

CONSTRUCTION FORECAST BY ASSET CLASS2019 2020 2021

Multi-unit housing -9.2% -6.9% 2.3% Despite recentgrowth, Starts willdecline in the nearterm and into mid-2020.

Office buildings 5.2% -0.7% 8.8% Activity will risethrough the first halfof this year beforedeclining mildlythrough 2020.

Retail 7.0% 6.5% -4.4% Growth will take holdby the end of 2019and persist throughmuch of 2020.

Warehouse 14.9% 14.6% 9.8% This market willexpand throughoutthe length of thisforecast

QUESTIONS?Dianne Crocker, Principal Analyst, EDR Insightdcrocker@edrnet.com